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The Implementation Shortfall and T-Standard Debate

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There's a running debate in the transition management business: What's the best way to measure the cost of selling a portfolio and buying another?

Transition management, the business of selling the portfolios of fired money managers and buying new ones for recently hired managers, is wrestling with this very issue. Indeed, there's reason for this debate: Some transitions could be as large as $500 million, so a few basis points in costs could add up to millions of dollars drained out of a pension fund's asset base, and, consequently, out of the pockets of retirees.

The industry has leaned to the common metric of implementation shortfall-the arithmetical difference between the actual transition portfolio return, legacy and target, and the paper, or target, portfolio return. However, the use of implementation shortfall is where agreement ends and the debate begins over a transition.

"There's certainly lots of debate in measuring transitions," says John Kirk, president of New York-based Global Transition Solutions, a consulting firm that works with clients to find and evaluate providers of brokerage services.

Timing Issues

Kirk is skeptical about the claims of transition providers who say it is difficult to measure one transition against another: Transition providers say each transition is different than the next because of variables in the marketplace like volatility and liquidity.

Include Hari Achuthan, Credit Suisse's director of pension strategies and transition management, among the camp that says implementation shortfall has some weaknesses as a benchmark.

"It doesn't recreate the framework in which a transition took place," he says. It also doesn't measure the different factors that affect how the manager executes the transition, he adds. For example, the time it takes to complete a transition is just one factor that can dramatically affect implementation shortfall, skewing the comparisons.

Transitions can take one day-or weeks or months, providers say. Therefore, the varied circumstances of each transition can mislead clients trying to figure out a transition beyond the raw portfolio numbers before and after. There's often confusion and controversy because implementation shortfall is measured from the point of view of the transition provider, not the client, some providers claim.

Still, Kirk's not buying that. He says there should be no confusion if a client uses a consultant, or independent third party, to measure the effectiveness of a transition. He also dismisses the time issue.

"The general rule is that it should be done within one trading session, unless there are very serious liquidity issues," Kirk says. He adds that the probability of bad trades greatly increases when the transition takes more than one day. He also warns that some transition providers, trying to sell their services, take advantage of a lack of common standards.

Real Cost

Providers can try to sell clients by promising a lower implementation shortfall number than a competitor and delivering that lower rate. But a good number can mislead the client. Indeed, a large implementation shortfall is not necessarily bad, if the overall portfolio performance is good; and the reverse is also true, Achuthan explains (see related story).